Goldman Sachs stock (NYSE: GS), the market leader in the investment banking space, gained roughly 40% – increasing from about $264 at the beginning of 2021 to around $369 currently, outperforming the S&P500, which grew 11% over the same period. The rise was in line with other U.S bank stocks as evident from Dow Jones U.S. Banks Index (up 36% YTD).
There were two clear reasons for this: First, the approval of the $1.9 trillion stimulus package. Second, the fast-paced Covid-19 vaccination drive in the U.S – 47% of the U.S population has already received at least one dose. Both of the above factors strengthen the prospects of a strong economic recovery, boosting investor sentiment.
But is this all there is to the story?
Not quite, despite the recent gains, Trefis estimates Goldman Sachs’ valuation to be around $385 per share – slightly above the current market price – based on a key opportunity and one risk factor.
The opportunity we see is an improved trajectory for Goldman Sachs’ revenues over the subsequent quarters. Goldman Sachs witnessed significant growth in the top-line for the full year 2020. It reported $44.6 billion in revenues – up 22% y-o-y, primarily driven by a 24% increase in investment banking and a 43% jump in global markets (sales & trading) businesses. While the rise in investment banking was due to higher underwriting volumes, reflecting an increase in initial public offerings (IPO) and debt origination activity, sales & trading benefited from higher trading volumes due to the impact of the Covid-19 crisis. Notably, both the above businesses cumulatively generate around 61% of the total revenues, which rose to 69% in 2020. Further, the bank’s Assets under Supervision (AuS) grew 18% y-o-y to $1.5 trillion by the end of the year.
The same trend continued in the first-quarter FY2021 as well, with the bank outperforming the consensus estimates by a huge margin – revenues doubled on a year-on-year basis to $17.7 billion in the quarter. While all its segments posted growth, the rise could mainly be attributed to a 73% y-o-y increase in investment banking and a 47% growth in global markets (highest quarterly net revenues since 2010). Notably, the bank’s asset management revenues increased from -$96 million in the year-ago period to $4.61 billion, reflecting record revenues in the Equity investments sub-segment. Further, GS has seen continuous growth in Assets under Supervision (AuS) over the recent quarters, which touched $1.56 trillion in Q1 – up 2% sequentially, benefiting its asset management segment. That said, higher trading volumes and an unusual jump in underwriting deal volumes are expected to normalize with recovery in the economic conditions. But, till then, sales & trading and investment banking will likely dominate its quarterly results. Further, Goldman’s core banking operations are significantly smaller than its peers. Hence, the low-interest-rate environment is unlikely to have a considerable impact on its top-line. Overall, we expect GS’ revenues to be around $49.8 billion for FY2021.
Revenue growth coupled with lower operating expenses is likely to improve the bank’s profitability figures in FY2021 – adjusted net income figure of $14.8 billion (up 66% y-o-y). It is likely to increase the EPS from $24.74 to $44.02 for the year, which coupled with the P/E multiple of just below 9x will lead to a valuation of around $385.
Finally, how much should the market pay per dollar of Goldman Sachs’ earnings? Well, to earn close to $44.02 per year from a bank, you’d have to deposit about $4402 in a savings account today, so about 100x the desired earnings. At Goldman Sachs’s current share price of roughly $369, we are talking about a P/E multiple of just above 8x. And we think a figure closer to 9x will be appropriate.
That said, banking is a risky business right now. Growth looks less promising in lending, and near-term prospects are less than rosy. What’s behind that?
Goldman Sachs increased its provisions for loan losses in FY2020 to compensate for the higher risk of loan defaults. The bank has a portfolio of around $105 billion in total loans (as per March 2021 figures) and any sudden uptick in the Covid-19 cases or deterioration in the economic conditions can expose Goldman Sachs to sizable loan defaults. To sum things up, we believe that Goldman Sachs stock has limited upside potential.
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